Congress looks at re-regulation of banks

House could assign special committee to rewrite the rules, Frank says

WASHINGTON (MarketWatch) -- The U.S. financial system certainly faces increased regulation and government supervision, but what form that enhanced oversight will take is not clear.

Former government officials and leaders of financial-services industry groups debated the issue in front of the House Financial Services Committee on Tuesday, as one top leader suggested that the House might create a special select committee to rewrite the rules of the road for the financial-services industry as it emerges from its worst crisis since the Great Depression.

During a break in the hearing, Rep. Barney Frank, D-Mass., said he was open to the idea of a select committee, according to a report in the Congressional Quarterly. "I think that's probably going to happen," Frank said. "The one thing I'm determined to do is not fight about turf."

One witness at the hearing, University of Rochester President Joel Seligman, suggested that Congress could break through institutional inertia by having a select committee come up with the new regulatory system for the industry.

Currently, oversight over financial institutions and markets is shared by four different committees in the House and four more in the Senate. "The most difficult issues in discussing appropriate reform of our regulatory system become far more difficult when multiple congressional committees with conflicting jurisdictions address overlapping issues," Seligman said.

House leaders have not yet examined the idea in detail and are not ready to endorse it or reject it, a spokesman for Speaker Nancy Pelosi said.

In best interest

The industry recognizes that more regulation is on its way. No one expects that the massive bailout wouldn't be followed by efforts to rein in the banks, brokers and insurance companies. In fact, two industry witnesses said tighter regulation is in their best interest.

"Modernizing our financial regulatory structure not only will help to regain the trust and respect of consumers and markets everywhere, but also will preserve our leadership role in the global financial marketplace," said Steve Bartlett, head of the Financial Services Roundtable, an organization representing the largest companies in the industry.

In particular, Bartlett said, the United States has so many different regulators that gaps between them can be easily exploited. The subprime boom largely developed in unregulated sectors, not in regulated banks, said Ed Yingling, president of the American Bankers Association.

Two former Clinton administration economic advisers urged Congress to impose tougher and more comprehensive regulation.

Alice Rivlin, former vice chairman of the Federal Reserve and now a fellow at the Brookings Institution, advised against a "grand new structure of regulatory relationships." Instead, "I would start where we are and work to clarify and strengthen the roles of the agencies we have," she said.

Ideology will get in the way, and those who hope to rewrite the rules "should check their slogans at the door," Rivlin said. "We don't need more or less regulation; we need smarter regulation."

"We certainly need to be more creative about curbing asset bubbles," Rivlin said. "Maybe we have to invent another instrument specifically aimed at slowing asset bubbles."

Rivlin and another witness, Joseph Stiglitz, warned that some flaws in the financial structure won't be easy to regulate, including the incentive structure and the lack of transparency in complex financial instruments.

"Markets only work well when private rewards are aligned with social returns," said Stiglitz, a former Clinton adviser and a winner of the Nobel prize in economics.

Safety net for bankers

Stiglitz argued that recent history is full of bank bailouts, from the S&L collapse to the Mexican bailout to the Asian financial crisis to the current meltdown. What they all have in common is that the taxpayers stepped in to rescue American banks and their shareholders. Clearly, bankers run their businesses knowing that, if they ever get in really hot water, Washington will save them. That has got to change, he said.

"Well-functioning markets require a balance between government and markets," Stiglitz said. "Markets often fail, and financial markets have, as we have seen, failed in ways that have large systemic consequences."

"Financial markets are not an end in themselves but a means: they are supposed to perform certain vital functions which enable the real economy to be more productive, including mobilizing savings, allocating capital, and managing risk, transferring it from those less able to bear it to those more able," Stiglitz said. The financial system has utterly failed in these most important tasks, yet those who run these companies have become fabulously wealthy.

The Republicans on the House committee wanted the hearing on Tuesday to also examine Fannie Mae, Freddie Mac and the Community Reinvestment Act. Chairman Frank rebuffed them, but the Republicans have not given up.

They sent a letter to Attorney General Michael Mukasey on Tuesday, demanding that the Justice Department widen its ongoing probe into mortgage fraud to include an investigation into what part fraud and malfeasance by top officials at Fannie and Freddie and "overzealous lending" encouraged by the CRA may have played in the current crisis.

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